The Death of Indian Outsourcing Is Imminent

06/05/2017 11:32 am ET

On February 29, 2008, I published the Forbes column that remains a highlight in my career in tech journalism: The Coming Death of Indian Outsourcing. I found myself on the receiving end of a deluge of hate mail on a scale that I have never encountered before or after. I am known as a relatively balanced, objective, and fair commentator on the state of the industry. I don’t sensationalize issues unnecessarily. This article, that I thought was sound in its logical analysis, triggered an immense defensive reaction.

Let me familiarize you with my argument first, before we get to the issue on hand:

India is riding high on outsourcing.

Information technology and IT-enabled services will employ 4 million people in 2008 and account for 7% of gross domestic product and 33% of India’s foreign-exchange inflows, according to Nasscom, an Indian IT industry organization.

The death of this industry is far from anyone’s mind.

However, the reality is that wages are rising in India. The cost advantage for offshoring to India used to be at least 1:6. Today, it is at best 1:3. Attrition is scary.

Jobs that are low value-added and easily automatable should and will disappear over the next decade.

People talk a lot about India moving up the value chain. Some of that has indeed happened. An industry that started gaining momentum when Indian software developers were tapped to help fix the “Y2K” problems in old software code has blossomed beautifully into one that offers a much more comprehensive spectrum of services.

Yet, India, for all its glory, is still the world’s back office. India’s tech industry is a “services” industry. The Indians don’t do the thinking. The customers do. India executes.

As a result, India has not learned to invent technology products of its own.

Barring a few exceptions, the huge amount of venture capital chasing India finds it difficult to be deployed. There is way too much money, way too few deals.

Instead, tech-sector VCs are now diverting capital to retail, real estate, hotels and other non-tech sectors.

Most of the 4 million people that the industry employs have now “arrived.” They have breezed through the milestones that their fathers had to toil all their lives to reach. A phone. A watch. A TV. A car. A house.

They are complacent. They will not take risks. They have “outsourced” thinking to their customers.

As the 1:3 cost structure becomes 1:1.5, it will soon become inefficient to use Indian labor. Why not Oklahoma or British Columbia? For many Europeans, Eastern Europe has already become more compelling than India. The pure labor arbitrage equation will no longer balance.

ADP, the largest U.S. payroll services provider, has 45,000 employees worldwide, of which only 2,500 are in India. It has around 1,000 workers in El Paso, Texas, it’s expanding a location in Augusta, Ga., and it’s opening a facility in Jackson, Miss. It’s also growing a location in Halifax, Canada. ADP isn’t moving its workforce to India–it’s hedging its bets geographically. On a recent earnings call, ADP’s chief executive used terms such as “smartshoring,” and “nearshoring” to describe the strategy.

The software as a service (SaaS) megatrend in technology also plays against India.

Here’s an example: There’s a tiny Silicon Valley start-up called InsideView. It helps customers to generate sales leads, qualify those leads and use technology tools to help find big sales opportunities for customers.

In November 2007, InsideView acquired a company called TrueAdvantage, which did the exact same thing manually with a team of 150 people in India. After the acquisition, InsideView moved all 2,500 of TrueAdvantage’s customers over to its SaaS solution. All 150 TruAdvantage employees in India were laid off.

That’s been a familiar tale in Detroit–but not so far in India. But that’s changing.

Indian powerhouses like Infosys and Wipro must diversify their portfolios away from pure body-shopping and process competencies to technology-driven advantages. They, too, could build–or acquire–SaaS businesses.

So far that’s not happening. Infosys is still hiring thousands of new employees in India every year. The mood is upbeat. Nasscom is forecasting 25% annual growth in the Indian IT services industry for the next few years. The golden goose is still laying large, warm eggs, enough to feed the 4 million and their families, servants, chauffeurs and cooks.

Meanwhile, the workforce is getting comfortable in their cubicle chairs, just as the turkey gets comfortable before Thanksgiving.

Forbes recently published some scary statistics on wage inflation in India. (See “Indian Employees Enjoying Swift Pay Hikes.”) Salaries rose 15.1% in 2007, up from 14.4% the previous year. The 2008 forecast: 15.2%. This would be the fifth consecutive year of salary growth above 10%.

Add to that the appreciation of the rupee against the weakening dollar, and its impact on the labor arbitrage market.

Is the death of Indian outsourcing all that far off?

Assuming a 15% year-to-year salary hike rate, and a 2007 cost advantage of 1:3 in favor of India, if U.S. wages remain constant, India’s cost advantage disappears by 2015. Then what?

Well, we’re in 2017. Trump is in the white house. America is fed up with jobs going offshore. Protectionism is in the air. The cost advantage has become dramatically less compelling for labor arbitrage to be attractive. Automation, especially Artificial Intelligence driven automation, is wiping out jobs brutally and decisively.

First, Indian entrepreneurs have become a credible force in developing software products, not just contract services. It happened slowly. There were knock-offs of western innovation mostly, but that doesn’t really matter. The mindset shift was very difficult to achieve. It has now come about, and the woes of the IT services industry will accelerate the trend.

My prediction: More product entrepreneurs will hit the market. This may very well be an inflection point for India’s quest to become a product-based industry, moving away from its services legacy. Of course, there will be services as well, but not as much low-end, commodity services. There will be higher value services. Integration of products that are built in India, for example. Interesting and creative ways of leveraging SaaS-enabled BPO, an area that remains under-explored to this day. I have written a lot about this topic over the years as well. You can go read some of those articles on my blog.

Second, Indian SMEs have so far been unable to afford technical talent because of the industry’s appetite for skilled resources. As such, India’s product entrepreneurs catering to this market have had a hard time scaling. Sales cycles are very long. This implosion will free up large numbers of technically skilled professionals.

My hope: This immense body of technology-comfortable professionals will get redeployed into the Indian SME sector, bringing with them the ability to dramatically upgrade technology penetration in that sector. If we can infiltrate Indian SMEs with a million tech-savvy people who are comfortable finding technology online, evaluating products on a web self-service mode, and buying software without requiring ridiculous levels of hand-holding, India will experience an unlocking of productivity and value at a giant scale.

The coupling of the above two trends – more product entrepreneurs catering to Indian SMEs equipped with savvy technology buyers on the other side – would be the single biggest positive outcome of the imminent death of India’s outsourcing industry.

And then, we can all sing Leonard Cohen’s Hallelujah at the top of our voices.